Updated: Jul 13, 2021
July 12, 2021 | This week in The Institutional Risk Analyst, we prepare for the media fest known as large cap bank earnings. We held forth on the subject earlier (“Update: Top Five US Banks | JPM C BAC WFC USB”).
July 13, 2021 CNBC WEX
To summarize for new arrivals, Q2 bank earnings will be inflated by GAAP adjustments to income as reserves put aside last year migrate back into income this year. But Q2 2021 will likely be the peak for US bank earnings in 2021. In terms of run rate revenue going forward, investors and analysts ought to look at 2019 rather than 2020 as a baseline for forward estimates.
We suspect that investment banking performance will be strong based upon the results last month from Jefferies Financial Group (NYSE:JEF). H/T to Dick Bove. JEF is a lone broker dealer model operating among the ersatz banks such as Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS). Indeed, Charles Schwab (NYSE:SCHW) now has significantly more core deposits than either GS or MS.
While earnings will be up big vs 2020, it is 2019 that is the relevant comparison. After the surfeit of unneeded loan loss reserves is exhausted, we suspect that the US banking sector will resume its brutal march towards zero net-interest margin. Only an end to quantitative easing by the Federal Open Market Committee can change this trajectory.
“The average net interest margin contracted 57 basis points from a year ago to 2.56 percent, the lowest level on record in the Quarterly Banking Profile (QBP),” noted the FDIC in Q1 2021. “Net interest income declined $7.6 billion (5.6 percent) from first quarter 2020 as the year-over-year reduction in interest income (down $29.8 billion, or 17.6 percent) outpaced the decline in interest expense (down $22.2 billion, or 68.7 percent). Despite the aggregate decline in net interest income, more than three-fifths of all banks (64.4 percent) reported higher net interest income compared with a year ago.”
Below are some thoughts on the commercial banks that report tomorrow starting with JPMorgan (NYSE:JPM):
JPM: The Street has JPM doing ~ $9 per share in 2021, increasingly magically to $13 in 2022. Revenue is expected to be down this year and flat in 2022. JPM was trading around 1.9x book value at Friday’s close, up almost 60% YTD. Note, however, that JPM has lagged the other large cap names. And all of these stocks have essentially traded sideways since institutional managers rushed into these names early in 2021.
GS: Goldman Sachs is expected to do $8.50 per share in earnings in Q2 2021 and $45 for the full year, but the Street then has GS earnings falling in 2022 to below $30 per share. Go figure. Like many financials, the GS equity market valuation has basically doubled in the past year on flat revenue. If you want earnings volatility, you’ve come to the right place.
FRC: First Republic Bank (NYSE:FRC) closed Friday a bit over 3x book value, a premium valuation for this high-touch asset manager. The Street has FRC reporting $7.50 per share in 2021 and $8 in 2022 with 20% revenue growth, of note. The growth rate magically falls to just 13% in 2022. The good news is that much of FRC revenue comes from non-interest fee income.
The key takeaway from Q2 2021 bank earnings is that Q2 is likely to be the best quarter for US banks for the rest of 2021 and thereafter. Unless there is a fairly radical change in FOMC policy, we expect bank NIM to remain under downward pressure, especially with longer-dated benchmark rates falling and little evidence of loan growth.
Source: FDIC/WGA LLC
Funding costs for the US banking sector are likely to fall again to all-time lows in Q2 2021, but cheap liquidity c/o the FOMC does little for bank earnings when asset returns are also falling. As the FDIC noted last quarter: “The average yield on earning assets declined 1.1 percentage points from the year-ago quarter to 2.76 percent, while the average cost of funding earning assets declined 54 basis points to 0.20 percent, both of which are record lows.”